Do you want to 'kill two birds with one stone' through smart investment-cum-tax planning?
If yes, then you should consider investing a part of your investible income in equity linked savings scheme (ELSS) of mutual funds. ELSS is an efficient investment tool that offers the twin-advantage of healthy capital appreciation and reduced tax burden. In our work-a-day life, we exert ourselves utmost to save every penny but are exasperated when taxes eat into our savings.
In order to save on tax, we have the option to invest a maximum of Rs 1,00,000 in various tax saving instruments under Section 80C of the Income Tax Act.
The eligible investments for availing Section 80C benefits include contribution to Provident Fund or Public Provident Fund (PPF), payment towards life insurance premium, investment in pension plans/ specified government infrastructure bonds/ National Savings Certificates (NSC)/ Equity Linked Savings schemes (ELSS) of mutual funds, payment towards principal repayment of housing loan (also any registration fee /stamp duty paid), and payments towards tuition fees for children to any school or college or university or similar institution (only for 2 children).
If you do a cost-benefit analysis of ELSS, PPF and NSC, then you will find that ELSS offers you manifold advantages/ benefits as compared to the other two tax savings instruments.
ELSS has a lock-in of only three years, whereas PPF and NSC have a longer lock-in period of 15 years and six years respectively. PPF and NSC fetch you a return at a compounded annual growth rate (CAGR) of 8 per cent while the average returns over three years in ELSS, which allows investors to participate in the India growth story by investing its money in shares, for the top five schemes as on November 30, 2007 is in the region of 50 per cent.
It would not be out of place at this point to slip in a caveat emptor that in the case of mutual fund investments past performance may not be sustained in future as equity markets are affected by events, global as well as domestic.
The maximum investment an individual can make in PPF under Section 80C is Rs 70,000, whereas it is Rs1,00,000 in the case of NSC and ELSS. When it comes to reaping taxation benefits, ELSS scores over PPF and NSC. As per current tax laws if you invest in ELSS, then dividend and capital gains are tax-free. While interest received in the case of PPF is tax-free, the same is not true in the case of NSC.
How to start an ELSS account?
There are two ways to invest in ELSS.
~ Invest a fixed amount every month through systematic investment plan (SIP) in ELSS and reduce the burden of large investment towards the end of financial year.
~ Invest lump sum at any point of time.
Why SIP route for ELSS?
One of the best ways to invest is to save and invest on a regular basis through SIPs. SIP is a planned investment programme, whereby an investor invests small amounts of his/her savings in mutual funds at regular intervals.
SIP helps an investor take advantage of the fluctuations in the stock markets by rupee cost averaging (in a rising equity market an investor gets fewer MF units but when the market is sliding he/she gets more MF units) and also helps him/ her reap the benefits of compounding.
A SIP in ELSS offers an investor the best combination of investments -- tax-savings and capital appreciation -- available to investors. The minimum investment in an ELSS through the SIP route can be as small as Rs 500.
By investing regularly in ELSS, the problems of wrong timing, wrong stock selection and burden towards the end of financial year is reduced substantially.
Since ELSS has a lock-in of three years, the fund manager does not face any redemption pressure. This is important as the manager has the elbow-room to allow the stocks in his/her portfolio to mature. He/ she is not under undue pressure to sell stocks which are expected to fetch good returns over a two-three year horizon.
In sharp contrast, open-ended schemes can be likened to an expressway which has an exit every 500 meters. So, when investors in an open-ended scheme go for redemption, the fund manager has no choice but to sell stocks which have the potential to grow over a two-three year period.
While choosing ELSS an investor would do well to keep in mind the size, experience, quality and consistency of fund houses over a period of time. If you are building a nest-egg and are conservative, then you should consider channeling your precious resources into ELSS even as you apportion a small part of your savings to PPF and NSC.
The author is a certified financial planner. He is also national head (Wealth management & portfolio management services), Almondz Global Securities. The views expressed here are personal.